Forked Tongue

When it comes to private student loans, loan giant Sallie Mae speaks out of both sides of its mouth. Case in point: Sallie Mae officials say they go out of their way to persuade students to exhaust their federal student loan eligibility before taking out more costly private loans. Not exactly.

It's true that on its website and in some of its marketing material, the company urges students to follow "Sallie Mae's 1-2-3 approach to paying for college," which recommends that they first apply for grants and scholarships, then for federal loans, and if a gap remains, then, and only then, consider taking out private loans. "Remember you should only use private student loans as extra funding after you've used all other sources of financial aid," a Sallie Mae podcast on the 1-2-3 approach states. "As with any student loan, always be conservative. You want to borrow only what you absolutely need to pay for school, not your lifestyle."

Sounds like good corporate citizen behavior, right? We thought so, until we saw the advertisement below on the Google search engine in which the primary selling point for Sallie Mae's private loans is that students don't have to file the Free Application for Federal Student Aid (FAFSA) to get them.

"No FAFSA" blares the Sallie Mae paid for advertisement.

In other words, Sallie Mae is marketing the convenience of applying for private loans, in contrast to federal loans. Unlike cheaper, safer federal loans, there are no lengthy forms to fill out and you can get "quick preapproval." Students can obtain up to $40,000 in loans, so there is little need to apply for federal loans in the first place. All you have to do is click on the ad and you are taken to a page that includes a link to the "quick online application and pre-approval process." (Although to be fair, in teeny-tiny type, buried amidst tax code references, Sallie Mae does say "students seeking federal financial assistance should seek that assistance first." The size and placement bespeak a disingenuousness, however.)

Sallie Mae is hardly the only private lender to make this type of implicit avoid the FAFSA pitch. But it is the largest student loan company in the country and if it decided to provide private loans only to those who had first exhausted their federal student loan options, it could have a major impact on borrowers' lives and the loan industry as a whole.

In May, JC Flowers and Company, the private equity firm that was poised to purchase Sallie Mae had promised to introduce reforms to the company's lending practices including "new disclosure and certification procedures" designed to "ensure that students understand all lower-cost options before taking out private loans." Such changes would be welcome, and we hope that Sallie Mae's leaders would consider moving forward with them even though the buyout deal has collapsed.

Federal Loan Exhaustion

Why does Sallie Mae's marketing matter so much? Because according to the Institute for Higher Education Policy, 20 percent of dependent students -- one in five students -- with private loans take out no federal student loans, even though they're vastly cheaper. An additional 19 percent of private loan students who also have federal loans fail to borrow up to the federal limits.

Now a minority of students may have legitimate reasons for taking out private loans instead of much cheaper and safer federal loans, but it's difficult for us to imagine many good reasons why. As Sallie Mae acknowledges in its "1-2-3" podcast, federal loans are a much, much better deal for students than private student loans, and offer important protections and more flexible repayment options than private loan providers supply.

What can policymakers do about this federal loan exhaustion issue? Well, currently two options are on the table. Congress could require lenders to more clearly disclose the benefits of borrowing federal loans first, as legislation that the Senate Banking Committee approved in August would do. But as we have seen with Sallie Mae as advertised on the Google website, lenders are apt to say and do two very different things.

Another option is to require colleges to certify private education loans before students can receive them. As we've noted, financial aid administrators at Barnard College and Colorado State University have shown the benefits of this approach. Through targeted counseling efforts that take place prior to certification, Barnard and the much larger Colorado State have been able to dissuade students from taking on private loans prior to exhausting their federal student loan eligibility first.

On the other hand, our reporting and that of others has shown that colleges are not above reproach in steering students to lenders that have provided their institutions and them with gifts and payments. We have also found that some colleges have put students in harm's way by including private loans in the financial aid packages that they offer students. This latter practice gives students the misleading impression that they are obligated to take out these loans. It also gives them the impression that these loans have the colleges' imprimatur -- and therefore must have pretty reasonable terms, which they often do not.

In Search of a Good Answer

How does one promote federal loan exhaustion prior to private loan assumption? In the absence of a more creative approach, it comes down to a policy decision between requiring lenders to supply more information to borrowers vs. requiring schools to certify private loans prior to student assumption.

Who do you trust more to protect student loan borrowers? The lenders or the colleges? Faced with only those two options, we'd have to go with the colleges, but with some serious reservations. In the coming days, we'll try to find a better answer and in the meantime welcome your suggestions. Maybe JC Flowers has an idea.